Fifth Third Bank 2012 Annual Report Download - page 93

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
91 Fifth Third Bancorp
on the expected net charge-offs. Loss rates are based on the trailing
twelve month net charge-off history by loan category. Historical loss
rates may be adjusted for certain prescriptive and qualitative factors
that, in management’s judgment, are necessary to reflect losses
inherent in the portfolio. Factors that management considers in the
analysis include the effects of the national and local economies;
trends in the nature and volume of delinquencies, charge-offs and
nonaccrual loans; changes in loan mix; credit score migration
comparisons; asset quality trends; risk management and loan
administration; changes in the internal lending policies and credit
standards; collection practices; and examination results from bank
regulatory agencies and the Bancorp’s internal credit reviewers.
The Bancorp’s primary market areas for lending are the
Midwestern and Southeastern regions of the Unites States. When
evaluating the adequacy of allowances, consideration is given to
these regional geographic concentrations and the closely associated
effect changing economic conditions have on the Bancorp’s
customers.
In the current year, the Bancorp has not substantively changed
any material aspect to its overall approach to determining its ALLL
for any of its portfolio segments. There have been no material
changes in criteria or estimation techniques as compared to prior
periods that impacted the determination of the current period
ALLL for any of the Bancorp’s portfolio segments.
Reserve for Unfunded Commitments
The reserve for unfunded commitments is maintained at a level
believed by management to be sufficient to absorb estimated
probable losses related to unfunded credit facilities and is included
in other liabilities in the Consolidated Balance Sheets. The
determination of the adequacy of the reserve is based upon an
evaluation of the unfunded credit facilities, including an assessment
of historical commitment utilization experience, credit risk grading
and historical loss rates based on credit grade migration. This
process takes into consideration the same risk elements that are
analyzed in the determination of the adequacy of the Bancorp’s
ALLL, as discussed above. Net adjustments to the reserve for
unfunded commitments are included in other noninterest expense
in the Consolidated Statements of Income.
Loan Sales and Securitizations
The Bancorp periodically sells loans through either securitizations
or individual loan sales in accordance with its investment policies.
The Bancorp recognizes the sale of loans in accordance with the
sale accounting criteria under ASC Topic 860 – Accounting for
Transfers of Financial Assets. The sold loans are removed from the
balance sheet and a net gain or loss is recognized in the Bancorp’s
Consolidated Financial Statements at the time of sale. The Bancorp
typically isolates the loans through the use of a VIE and thus is
required to assess whether the entity holding the sold or securitized
loans is a VIE and whether the Bancorp is the primary beneficiary
and therefore consolidator of that VIE. If the Bancorp holds the
power to direct activities most significant to the economic
performance of the VIE and has the obligation to absorb losses or
right to receive benefits that could potentially be significant to the
VIE, then the Bancorp will generally be deemed the primary
beneficiary of the VIE. When the Bancorp previously sold loans
into isolated trusts or conduits, it obtained one or more
subordinated tranches or other residual interests in these trusts or
conduits, as well as the servicing rights to the underlying loans.
Effective with the adoption of amended VIE consolidation
guidance on January 1, 2010, the Bancorp was required to
consolidate these VIEs, and accordingly, the underlying loans and
other assets and liabilities of these VIEs were included in the
Bancorp’s Consolidated Balance Sheets. See Note 10 for further
information on these consolidated VIEs.
The Bancorp’s loan sales and securitizations are generally
structured with servicing retained. As a result, servicing rights
resulting from residential mortgage loan sales are initially recorded
at fair value and subsequently amortized in proportion to and over
the period of estimated net servicing revenues and are reported as a
component of mortgage banking net revenue, in the Consolidated
Statements of Income. Servicing rights are assessed for impairment
monthly, based on fair value, with temporary impairment
recognized through a valuation allowance and permanent
impairment recognized through a write-off of the servicing asset
and related valuation allowance. Key economic assumptions used in
measuring any potential impairment of the servicing rights include
the prepayment speeds of the underlying loans, the weighted-
average life, the discount rate, the weighted-average coupon and the
weighted-average default rate, as applicable. The primary risk of
material changes to the value of the servicing rights resides in the
potential volatility in the economic assumptions used, particularly
the prepayment speeds. The Bancorp monitors risk and adjusts its
valuation allowance as necessary to adequately reserve for
impairment in the servicing portfolio. For purposes of measuring
impairment, the mortgage servicing rights are stratified into classes
based on the financial asset type (fixed rate vs. adjustable rate) and
interest rates. Fees received for servicing loans owned by investors
are based on a percentage of the outstanding monthly principal
balance of such loans and are included in noninterest income in the
Consolidated Statements of Income as loan payments are received.
Costs of servicing loans are charged to expense as incurred.
Reserve for Representation and Warranty Provisions
Conforming residential mortgage loans sold to unrelated third
parties are generally sold with representation and warranty
provisions. A contractual liability arises only in the event of a breach
of these representations and warranties and, in general, only when a
loss results from the breach. The Bancorp may be required to
repurchase any previously sold loan or indemnify (make whole) the
investor or insurer for which the representation or warranty of the
Bancorp proves to be inaccurate, incomplete or misleading. The
Bancorp establishes a residential mortgage repurchase reserve
related to various representations and warranties that reflects
management’s estimate of losses based on a combination of factors.
The Bancorp’s estimation process requires management to
make subjective and complex judgments about matters that are
inherently uncertain, such as, future demand expectations, economic
factors and the specific characteristics of the loans subject to
repurchase. Such factors incorporate historical investor audit and
repurchase demand rates, appeals success rates, historical loss
severity, and any additional information obtained from the GSEs
regarding future mortgage repurchase and file request criteria. At the
time of a loan sale, the Bancorp records a representation and
warranty reserve at the estimated fair value of the Bancorp’s
guarantee and continually updates the reserve during the life of the
loan as losses in excess of the reserve become probable and
reasonably estimable. The provision for the estimated fair value of
the representation and warranty guarantee arising from the loan
sales is recorded as an adjustment to the gain on sale, which is
included in other noninterest income at the time of sale. Updates to
the reserve are recorded in other noninterest expense.
Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements,
are carried at cost less accumulated depreciation and amortization.
Depreciation is calculated using the straight-line method based on
estimated useful lives of the assets for book purposes, while
accelerated depreciation is used for income tax purposes.
Amortization of leasehold improvements is computed using the